Is An Interest Only Loan For You?

Is a principal and interest loan better for you?

This depends a lot on your situation and probably more on what you think the property market is going to do if you are an investor.

Interest only loans have significant lower repayments as they have no principal amount attached. This alone provides a great incentive for investors as this frees up a lot of essential cash flow. It can be the difference of getting a deal across the line or not for a lot of people.

Example: $300,000 loan. Interest only of 8% = $24,000 P/A in payments. (300,000 x 8%)

$300,000 loan   Principal & Interest= $27,780 P/A in Payments

The interest only repayments are $3780 P/A lower which equates to over $72 P/W.

This could be a fair amount for a first homeowner or first time investor.

Even some homeowners utilise these types of loans to make the most of lower repayments however the thought of not actually paying any of your loan down is a hard concept to grasp.

Investors however realise that the price of financing today is always cheaper in the future as the trusty factor of inflation actually reduces the size of your loan at the rate of inflation. You would hope you property goes up with inflation though to make it work!

Interest only loans have been around for over 90 years and are a great finance strategy if the asset is appreciating (going up in value) and the interest rate is still fairly low. That way the growth far out ways the cost of paying the loan and the loan actually decreasing.

The second and probably more popular reason for utilising interest only loans is that (subject to your specific taxation requirements) the interest component of an income producing assets loan is tax deductible.

So if you had a principal and interest loan for an investment property the interest component is tax deductible. If it was an interest only loan, the whole repayment is tax deductible. This helps servicing (negative gearing: see earlier post) for sure come tax time!

Everyone’s situation is very different and seeking great accounting advice (from property specific accountants) is recommended to ensure you get it right first time.

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